x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September
30, 2012

or

o
TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________
to _____________

Commission File Number: 000-28063

deltathree, Inc.

(Exact Name of Registrant as Specified
in its Charter)

Delaware

13-4006766

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification Number)

26 Avenue at Port Imperial, Suite #407, West New York, New Jersey

07093

(Address of principal executive offices)

(Zip Code)

(212) 500-4850

(Registrant’s telephone number,
including area code)

Indicate by check mark whether the registrant (1)
has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No
o

Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes x No
o

Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act.

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer ¨

Smaller reporting company x

Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of November
13, 2012, the registrant had outstanding 72,273,525 shares of common stock, par value $0.001
per share.

TABLE OF CONTENTS

Page

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

3

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

10

Item 4. Controls and Procedures

22

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

22

Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds.

22

Item 5. Other Information

22

Item 6. Exhibits

22

SIGNATURES

23

EXHIBIT INDEX

24

PART I

FINANCIAL INFORMATION

Item 1. Financial
Statements

DELTATHREE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

($ in thousands)

As of September 30, 2012

As of December 31, 2011

ASSETS

Current assets:

Cash and cash equivalents

$

288

$

214

Restricted cash and short-term investments (reclassified)

272

352

Accounts receivable, net (includes $160 and $158 as of September 30, 2012, and December 31, 2011, respectively, from a related party)

620

415

Prepaid expenses and other current assets (reclassified)

232

224

Inventory

47

46

Total current assets

1,459

1,251

Property and equipment, net

282

335

Deposits

77

78

Total assets

$

1,818

$

1,664

LIABILITIES AND STOCKHOLDERS’ DEFICIENCY

Current liabilities:

Accounts payable (includes $943 and $575 as of September 30, 2012, and December 31, 2011, respectively, to a related party)

1,603

1,469

Deferred revenues

676

522

Other current liabilities

857

830

Total current liabilities

3,136

2,821

Long-term liabilities:

Severance pay obligations

99

112

Long-term loan from a related party (reclassified)

4,183

3,133

Total long-term liabilities

4,282

3,245

Total liabilities

7,418

6,066

Stockholders’ deficiency:

Share capital:

Common stock, par value $0.001 per share; authorized: 225,000,000 shares; issued and outstanding: 72,273,525 at September 30, 2012, and December 31, 2011

72

72

Additional paid-in capital

176,991

176,893

Accumulated deficit

(182,663

)

(181,367

)

Total stockholders’ deficiency

(5,600

)

(4,402

)

Total liabilities and stockholders’ deficiency

$

1,818

$

1,664

See notes to unaudited condensed consolidated
financial statements.

3

DELTATHREE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

(unaudited)

($ in thousands, except share and per
share data)

Three Months Ended September 30,

Nine Months Ended September 30,

2012

2011

2012

2011

Revenues

$

3,522

$

2,215

$

9,773

$

8,205

Costs and operating expenses:

Cost of revenues

2,359

1,524

6,186

5,879

Research and development expenses

274

366

874

1,258

Selling and marketing expenses

467

424

1,520

1,546

General and administrative expenses

366

407

1,042

775

Accrual for commercial rent tax

-

-

-

300

Depreciation and amortization

39

36

109

141

Total costs and operating expenses

3,505

2,757

9,731

9,899

Income (loss) from operations

17

(542

)

42

(1,694

)

Interest expense, net

416

329

1,332

761

Loss before income taxes

(399

)

(871

)

(1,290

)

(2,455

)

Income taxes

2

1

6

9

Net loss

$

(401

)

$

(872

)

$

(1,296

)

$

(2,464

)

Net loss per share – basic and diluted

$

(0.01

)

$

(0.01

)

$

(0.02

)

$

(0.03

)

Basic and diluted weighted average number of shares outstanding

72,273,525

72,273,525

72,273,525

72,273,525

See notes to unaudited condensed consolidated
financial statements.

4

DELTATHREE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS

(unaudited)

($ in thousands)

Nine Months Ended September 30,

2012

2011

Cash flows from operating activities:

Net loss for the period

$

(1,296

)

$

(2,464

)

Adjustments to reconcile loss for the period to net cash provided by (used in) operating activities:

Accumulated interest on short-term loan

268

154

Depreciation and amortization

109

141

Amortization related to convertible notes

782

507

Tax provision

-

(158

)

Stock-based compensation

98

266

Accrual for commercial rent tax

-

300

Provision for losses on accounts receivable

-

146

Decrease in liability for severance pay, net

(13

)

(31

)

Exchange rates differences on deposits, net

1

2

Changes in operating assets and liabilities:

(Increase) decrease in accounts receivable

(205

)

247

(Increase) decrease in prepaid expenses and other current assets

(8

)

16

Increase in inventory

(1

)

(6

)

Increase (decrease) in accounts payable

134

(220

)

Increase (decrease) in deferred revenues

154

(144

)

Increase (decrease) in other current liabilities

27

(766

)

1,346

454

Net cash provided by (used in) operating activities

50

(2,010

)

Cash flows from investing activities:

Purchase of property and equipment

(56

)

(99

)

Release of restricted cash and short-term investment, net

80

32

Net cash provided by (used in) investing activities

24

(67

)

Cash flows from financing activities:

Payment of capital leases

-

(7

)

Short-term loan from a related party

-

2,000

Net cash provided by financing activities

-

1,993

Increase (decrease) in cash and cash equivalents

74

(84

)

Cash and cash equivalents at beginning of period

214

308

Cash and cash equivalents at end of period

$

288

$

224

5

Nine Months Ended September 30,

2012

2011

Supplemental schedule of cash flow information:

Cash paid for:

Interest on short-term loan from a related party

140

-

Taxes

245

47

Total

$

385

$

47

See notes to unaudited condensed consolidated
financial statements.

6

DELTATHREE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

(UNAUDITED)

1.

Basis of Presentation

Financial Statement Preparation

The unaudited condensed
consolidated financial statements of deltathree, Inc. and its subsidiaries (collectively referred to in this Quarterly Report on
Form 10-Q as the “Company”, “we”, “us”, or “our”), of which these notes are a part,
have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to
the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for annual financial statements. In the opinion of our management, all adjustments
(consisting only of normal recurring accruals) considered necessary for a fair presentation of the financial information as of
and for the periods presented have been included.

The results for the
interim periods presented are not necessarily indicative of the results that may be expected for any future period. The unaudited
condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and
notes for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the SEC on March 28, 2012,our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, filed with
the SEC on May 14, 2012, our Quarterly Report on Form 10-Q for the quarter ended June
30, 2012, filed with the SEC on August 13, 2012, and all of our other periodic filings, including Current Reports on Form
8-K, filed with the SEC after the end of our 2011 fiscal year and through the date of this Report.

Going Concern

The
Company has sustained significant operating losses in recent periods, which has resulted in a significant reduction in
its cash reserves. The Company and its subsidiaries have entered into four loan agreements with D4 Holdings, LLC,
its majority stockholder, pursuant to which D4 Holdings has agreed to provide the Company with loans in the aggregate
principal amount of $4,100,000. The initial Loan and Security Agreement, or the “First Loan
Agreement”, was entered into on March 1, 2010, and the Company has drawn the maximum principal amount available under
the First Loan Agreement. On August 10, 2010, the Company and its subsidiaries entered into the Second Loan and
Security Agreement, or the “Second Loan Agreement”, with D4 Holdings with a maximum principal amount of
$1,000,000, and the Company has drawn the maximum principal amount available under the Second Loan Agreement. In
connection with the Second Loan Agreement, the Company issued D4 Holdings a warrant to purchase up to 4,000,000 shares of the
Company's common stock at an exercise price of $0.1312 per share. On March 2, 2011, the Company and its subsidiaries entered
into the Third Loan and Security Agreement, or the “Third Loan Agreement”, with D4 Holdings, pursuant to which D4
Holdings agreed to provide the Company and its subsidiaries an additional line of credit in a principal amount of $1,600,000.
Pursuant to the terms of the Convertible Promissory Note, or the “Convertible Note”, issued by the Company in
connection with the Third Loan Agreement, D4 Holdings may elect to convert all or any portion of the outstanding principal
amount under the Convertible Note into that number of shares of the Company’s common stock determined by dividing such
principal amount by $0.08 (as may be adjusted under the terms of the Convertible Note). Simultaneous with the Company’s
entering into the Third Loan Agreement, D4 Holdings and the Company entered into an amendment of the First Loan Agreement,
pursuant to which (among other things) the maturity date for repayment of principal under the First Loan Agreement was
extended from March 1, 2011, to March 1, 2012. The maturity date was subsequently extended by oral agreement of the parties
to July 1, 2012, and then subsequently orally extended again to January 2, 2014, pending the parties finalizing and entering
into a formal amendment. In connection with the Third Loan Agreement, the Company issued D4 Holdings a warrant to purchase up
to 1,000,000 shares of the Company’s common stock at an exercise price of $0.096 per share. The Company has drawn
the aggregate principal amount available under the Third Loan Agreement, the principal amount of which can be converted by
D4 Holdings into an aggregate of 20,000,000 shares of the Company’s common stock. On September 12, 2011, the Company
and its subsidiaries entered into the Fourth Loan and Security Agreement, or the “Fourth Loan Agreement”, with
D4 Holdings, pursuant to which D4 Holdings agreed to provide the Company and its subsidiaries an additional line of credit in
a principal amount of $300,000. As of September 30, 2012, the Company had drawn down the aggregate amount of $200,000 from
D4 Holdings pursuant to notices of borrowing under the Fourth Loan Agreement.

As
of September 30, 2012, the Company had negative working capital equal to approximately $5.9 million as well as negative stockholders’
equity equal to approximately $5.6 million. The Company believes it is probable that it will continue to experience losses and
increased negative working capital and negative stockholders’ equity in the near future and may not be able to return to
positive cash flow before it requires additional cash (in addition to any further amounts it may borrow from D4 Holdings under
the Fourth Loan Agreement) in the near term. The Company may experience difficulties accessing the equity and debt markets and
raising additional capital, and there can be no assurance that the Company will be able to raise such additional capital on favorable
terms or at all. If additional funds are raised through the issuance of equity securities, the Company’s existing
stockholders will experience significant further dilution. Because of the Company’s significant losses to date and the Company’s
limited tangible assets, the Company does not fit traditional credit lending criteria, which could make it difficult for the Company
to obtain loans or to access the capital markets. If the Company issues additional equity or convertible debt securities to raise
funds, the ownership percentage of the Company’s existing stockholders would be reduced and they may experience significant
dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of the Company’s
common stock.

7

Due
to the limited availability of additional loan advances under the Fourth Loan Agreement, the Company believes that, unless it is
able to increase revenues and generate additional cash flows, its current cash and cash equivalents will not satisfy its current
projected cash requirements beyond the foreseeable future. As a result, there is substantial doubt about the Company’s ability
to continue as a going concern.

In
addition, unless the Company is able to increase revenues and generate additional cash flows, based on currently projected cash
flows the Company believes that it may be unable to pay future scheduled interest and/or principal payments under the various loan
agreements with D4 Holdings as these obligations become due. In the event that were to occur, if D4 Holdings is not willing to
waive compliance or otherwise modify the Company’s obligations such that the Company is able to avoid defaulting on such
obligations, D4 Holdings could accelerate the maturity of the Company’s debts due to it. Further, because D4 Holdings has
a lien on all of the Company’s assets to secure the Company’s obligations under the loan agreements, D4 Holdings could
take actions under the loan agreements and seek to take possession of or sell the Company’s assets to satisfy the Company’s
obligations thereunder. Any of these actions would likely have an immediate material adverse effect on the Company’s business,
financial condition or results of operations.

Due
to the Company’s ongoing losses and reduction in cash, the Company initiated restructuring activities beginning in the second
quarter of 2011 in an effort to cut operating costs significantly and better align the Company’s operations with its current
business model. In accordance with the restructuring, the Company instituted a reduction in force and decreased the
number of full time employees from approximately 53 to 37, reduced the salaries of all remaining employees by five percent, and
decreased non-material expenses as well as payments to be made to vendors and other third parties. As of September 30, 2012, the
Company had 23 full time employees.

In
view of the Company’s current cash resources, nondiscretionary expenses, debt and near term debt service obligations, the
Company may begin to explore all strategic alternatives available to it, including, but not limited to, a sale or merger of the
Company, a sale of its assets, recapitalization, partnership, debt or equity financing, voluntary deregistration of its securities,
financial reorganization, liquidation and/or ceasing operations. In the event that the Company requires but is unable to secure
additional funding, the Company may determine that it is in its best interests to voluntarily seek relief under Chapter 11 of the
U.S. Bankruptcy Code. Seeking relief under the U.S. Bankruptcy Code, even if the Company is able to emerge quickly from Chapter
11 protection, could have a material adverse effect on the relationships between the Company and its existing and potential customers,
employees, and others. Further, if the Company was unable to implement a successful plan of reorganization, the Company might be
forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code. There can be no assurance that exploration of strategic alternatives
will result in the Company pursuing any particular transaction or, if the Company pursues any such transaction, that it will be
completed.

Use of Estimates

Our consolidated
financial statements are prepared in conformity with accounting principles generally accepted in the United States, which require
management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements
and the accompanying notes. Actual results could differ materially from these estimates.

Concentration of Credit
and Business Risks

Financial
instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents
and trade accounts receivable. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based
upon payment history, age of the balance and the customer’s current credit worthiness, as determined by a review of the customer’s
current credit information. The Company monitors collections and payments from its customers and maintains an allowance for doubtful
accounts based upon historical experience and any specific customer collection issues that have been identified. A considerable
amount of judgment is required in assessing the ultimate realization of these receivables. Customer receivables are generally unsecured.

8

Sales to material customers
for each of the three months ended September 30, 2012 and 2011, and accounts receivable as of September 30, 2012, and December
31, 2011, were as follows:

Revenues

Accounts Receivable

Three Months Ended September 30,

As of

Customer

2012

2011

September 30, 2012

December 31, 2011

Reseller A

44

%

-

38

%

-

Reseller B

9

%

35

%

14

%

19

%

Affiliate A

10

%

-

-

-

Affiliate B

7

%

13

%

-

-

Service Provider A

5

%

11

%

21

%

38

%

Earnings per Common
Share

Basic earnings per
common share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the
reporting period. Diluted earnings per common share is computed by dividing net income by the combination of dilutive common share
equivalents, comprised of shares issuable under the Company’s stock option and stock incentive compensation plans, and the
weighted-average number of shares of common stock outstanding during the reporting period.Dilutive common share equivalents
include the dilutive effect of in-the-money shares, which is calculated based on the average share price for each period using
the treasury stock method. Under the treasury stock method, the exercise price of a share, the amount of compensation cost, if
any, for future service that the Company has not yet recognized, and the amount of estimated tax benefits that would be recorded
in additional paid-in capital, if any, when the share is exercised are assumed to be used to repurchase shares in the current period.

2.

Stock-Based Compensation

Options

Stock-based compensation
cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee’s
requisite service period in accordance with the provisions of “Compensation – Stock Compensation”
[ASC 718-10].

The Company has no
awards with market or performance conditions.

The risk-free interest
rate assumption is based upon observed interest rates appropriate for the terms of the Company’s employee stock options.
The Company does not target a specific dividend yield for its dividends payments but is required to assume a dividend yield as
an input to the Black–Scholes model. The dividend yield assumption is based on the Company’s history and expectation
of future dividends payout and may be subject to substantial change in the future. The expected life of employee stock options
represent the period the stock options are expected to remain outstanding. The Black-Scholes model assumes that an employee’s
exercise behavior is a function of the option’s remaining contractual life and the extent to which the option is in-the-money
(i.e., the average market price of the underlying stock during the period is above the strike price of the stock option).

Options to purchase
400,000 shares of the Company’s common stock were granted during the three months ended September 30, 2012.

3.

Commitments and Contingencies

Lease Commitments

The
Company leases its executive offices at 26 Avenue at Port Imperial, West New York,
New Jersey, and storage and equipment space at 117 Central Avenue, Hackensack, New Jersey. The
Company leases each of these facilities on a month-to-month basis. The aggregate rent expense,
net, for the two locations for the three months ended September 30, 2012, was $3,150.

Delta Three Israel
Ltd., a wholly-owned subsidiary of the Company (the "Subsidiary"), leases an office that houses the Company’s research
and development facilities in Jerusalem, Israel. The term of the lease is until June 30, 2015. Rent expense, net for the Subsidiary
for the three months ended September 30, 2012, was $36,750.

9

Legal Proceedings

On
July 5, 2011, the Company received a notice from the New York City Department of Finance, or the Department of Finance, which
claimed that the Company had not paid commercial rent tax required under the New York City Administrative Code from June 1998
through May 2008 for the two offices that the Company had leased during that time. The notice stated that the Company is
obligated to pay the outstanding tax amounts, as well as significant interest and penalties that were assessed on the unpaid
amounts as well as for the failure to file the applicable tax returns. The Company engaged outside counsel, which
began discussions with the Department of Finance, and contested the assessment and simultaneously attempted to negotiate a
significant reduction in the amounts to be paid. The Company’s appeal was rejected in July 2012 by an examiner in the
Department of Finance, and the Company has subsequently engaged and begun discussions with a manager in the Department of
Finance and submitted additional supporting materials. The final outcome of this assessment and our negotiations cannot
be determined at this time. In the event that the Company is required to pay all or most of the amounts claimed by
the Department of Finance this would have a material adverse effect on the Company’s financial condition. During
2011 the Company recorded $300,000 as a provision for commercial rent tax.

In addition, from time
to time the Company is a party to legal proceedings, much of which is ordinary routine litigation incidental to the business, and
is regularly required to expend time and resources in connection with such proceedings. Accordingly, the Company, in
consultation with its legal advisors, accrues amounts that management believes it is probable the Company will be required to expend
in connection with all legal proceedings to which it is a party.

Regulatory Taxes, Fees and Surcharges

Some state and local
regulatory authorities believe they retain jurisdiction to regulate the provision of, and impose taxes, fees and surcharges on,
intrastate Internet and VoIP telephony services, and have attempted to impose such taxes, fees and surcharges, such as a fee for
providing E-911 service. Rulings by the state commissions on the regulatory considerations affecting Internet and IP telephony
services could affect our operations and revenues, and we cannot predict whether state commissions will be permitted to regulate
the services we offer in the future.

The Company paid approximately
$245,000 of state and local taxes and other fees during the three months ended September 30, 2012. To the extent the Company
increases the cost of services to our customers to recoup some of the costs of compliance this will have the effect of decreasing
any price advantage the Company may have over traditional telecommunications companies.

In
addition, it is possible that the Company will be required to collect and remit taxes, fees and surcharges in other states and
local jurisdictions where it has not done so, and which such authorities may take the position that it should have collected. If
so, they may seek to collect those past taxes, fees and surcharges from the Company and impose fines, penalties or interest charges
on the Company. The Company’s payment of these past taxes, fees and surcharges, as well as penalties and interest charges,
could have a material adverse effect on the Company.

4.

Warrants and Convertible Note

As
discussed above under “Basis of Presentation”, the Company issued to D4 Holdings a warrant in connection with the Second
Loan Agreement and a warrant and the Convertible Note in connection with the Third Loan Agreement. The Company evaluated
the warrants in accordance with “Contracts in Entity's Own Equity” [ASC 815-40] and determined that the warrants should
be classified as equity and should not be considered derivatives. The Company accounted for the Convertible Note in accordance
with “Debt with Conversion and Other Options” [ASC 470-20], which requires the Company to recognize separately, at
issuance, the embedded beneficial conversion feature of the Convertible Note as additional paid-in capital. The amount to be recognized
is calculated as the difference between the effective conversion price of the convertible instrument and the fair value of the
underlying shares on the issuance date. As a result, the Convertible Note was initially recorded as having no value, as the beneficial
conversion feature exceeded the carrying value of the Convertible Note.

5.

Subsequent Events

On November 13, 2012, each of the Company,
the Subsidiary and DME Solutions, Inc. entered into the Third Amendment to Loan and Security Agreements, or the "Third Amendment",
and the Amendment to Warrant Agreements, or the "Warrants Amendment", with D4 Holdings. Pursuant to the Third Amendment
and the Warrants Amendment,

·

the maturity date for repayment of principal and interest under the First Loan Agreement was extended to January 2, 2014;

·

the maturity date for repayment of principal and interest under the Second Loan Agreement was extended to January 2, 2015;

·

the maturity date for repayment of principal and interest under each of the Third and Fourth Loan Agreements was extended to
January 2, 2016;

·

all interest outstanding under each of the loan agreements was added to the principal amount outstanding
under the respective loan agreement and the promissory notes issued pursuant to each respective
loan agreement was increased by such amount; and

·

the exercise price under each of the Warrant Agreements entered into by the Company and D4 Holdings as of February 12, 2009,
August 10, 2010, and March 2, 2011 was amended to $0.02 per share.

In connection with the extension of the
maturity dates under the Third Amendment, the Company issued to D4 Holdings a Warrant, or together with the Third Amendment and
the Warrants Amendment, the "Transaction Documents", exercisable for ten years, to purchase up to 10,000,000 shares of
common stock of the Company at an exercise price of $0.02 per share.

The Company is majority-owned by D4 Holdings.
The ultimate ownership of D4 Holdings includes owners of ACN, Inc. Each of Robert Stevanovski, Anthony Cassara and David Stevanovski,
members of the Company’s Board of Directors, is a principal of D4 Holdings. As a result, each of these individuals and may
be deemed to have a direct or indirect interest in the transactions contemplated by the Transaction Documents. In accordance with
the Company’s Audit Committee Charter, the Transaction Documents and the transactions contemplated thereby were approved
by the Audit Committee, which includes those directors who are not affiliated with D4 Holdings.

Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations

This Management’s
Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, should be read in conjunction
with the Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements
and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011.

10

Forward-Looking Statements

This Quarterly Report
on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on current
expectations, estimates, forecasts and projections about us, our future performance, the industries in which we operate our beliefs
and our management’s assumptions. In addition, other written or oral statements that constitute forward-looking
statements may be made by us or on our behalf. Words such as “may,” “expect,” “anticipate,”
“forecast,” “intend,” “plan,” “believe,” “seek,” “estimate,”
variations of such words and similar expressions are intended to identify such forward-looking statements. These statements
are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to assess. Therefore,
actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. These
risks and uncertainties include, but are not limited to, the following:

·

our ability to increase revenues and generate additional cash;

·

our ability to obtain additional capital in the near term to finance operations;

·

our ability to meet our obligations under outstanding indebtedness, and the impact of any remedies our secured lender may seek thereunder;

·

our ability to successfully pursue strategic alternatives in the event we are unable to increase revenues and generate additional cash;

·

our ability to retain key personnel and employees needed to support our services and ongoing operations and our ability to continue to effectively maintain our ongoing operations, especially following the reduction in force that we recently effected;

·

our dependence on a small number of key customers for a significant percentage of our revenue;

·

decreasing rates of all related telecommunications services;

·

the public’s acceptance of Video over Internet Protocol, and the level and rate of customer acceptance of our new products and services;

·

the competitive environment of VoIP telephony and our ability to compete effectively;

·

fluctuations in our quarterly financial results;

·

our ability to maintain and operate our computer and communications systems without interruptions or security breaches;

·

our ability to operate in international markets;

·

our ability to provide quality and reliable service, which is in part dependent upon the proper functioning of equipment owned and operated by third parties;

·

the uncertainty of future governmental regulation;

·

the outcome of our discussions with the New York City Department of Finance regarding the outstanding commercial rent tax, interest and penalties it claims we owe;

·

the impact of continuing unrest in the Middle East on our customers doing business in that region;

·

our ability to protect our intellectual property against infringement by others, and the costs and diversion of resources relating to any claims that we infringe the intellectual property rights of third parties;

the need for ongoing product and service development in an environment of rapid technological change; and

·

other risks referenced from time to time in our filings with the SEC.

For a more complete list and description of such risks
and uncertainties, as well as other risks, please refer to the section entitled "Risk Factors" in our Annual Report
on Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 28, 2012, as updated in our Quarterly
Report on Form 10-Q for the quarter ended March 31, 2012, filed with the SEC on May 14, 2012, and our Quarterly Report on Form
10-Q for the quarter ended June 30, 2012, filed with the SEC on August 13, 2012. Except as required under the
federal securities laws and the rules and regulations promulgated thereunder, we do not have any intention or obligation to update
publicly any forward-looking statements or risk factors after the filing of this report, whether as a result of new information,
future events, changes in assumptions or otherwise.

Overview

We
are a global provider of integrated video and voice over Internet Protocol, or VoIP, telephony services, products, hosted solutions
and infrastructure. We were founded in 1996 to capitalize on the growth of the Internet as a communications tool by commercially
offering Internet Protocol, or IP, telephony services, or VoIP telephony. VoIP telephony is the real-time transmission
of voice communications in the form of digitized “packets” of information over the Internet or a private network, similar
to the way in which e-mail and other data is transmitted. While we began as primarily a low-cost alternative source of wholesale
minutes for carriers around the world, we have evolved into an international provider of next generation communication services.

Today
we support tens of thousandsof active users around the globe through our service provider and reseller channel and our
direct-to-consumer channel. We have built a privately-managed, state-of-the-art global telecommunications platform using IP technology
and we offer a broad suite of private label VoIP products and services as well as a back-office platform. Our operations management
tools include, among others: account provisioning; e-commerce-based payment processing systems; billing and account management;
operations management; web development; network management; and customer care. Based on our customizable VoIP solutions, these
customers can offer private label video and voice-over-IP services to their own customer bases under their own brand name, a “white-label”
brand (in which no brand name is indicated and different customers can offer the same product), or the deltathree brand. At the
same time, our direct-to-consumer channel includes our joip Mobile application (which is a new cellular phone application providing
low cost mobile calls over 3G cellular networks as well as WiFi networks), iConnectHere offering (which provides VoIP products
and services directly to consumers and small businesses online using the same primary platform) and our joip offering (which serves
as the exclusive VoIP service provider embedded in the Globarange cordless phones of Panasonic Communications). We are able to
provide our services at a cost per user that is generally lower than that charged by traditional service providers because we minimize
our network costs by using efficient packet-switched technology and interconnecting to a wide variety of termination options, which
allows us to benefit from pricing differences between vendors to the same termination points.

11

Prior
to 1999, we focused on building a privately-managed, global network utilizing IP technology, and our business primarily consisted
of carrying and transmitting traffic for communications carriers over our network. Beginning in 1999, we began to diversify our
offerings by layering enhanced IP telephony services over our network. These enhanced services were targeted at consumers and were
primarily accessible through our consumer website. During 2000, we began offering services on a co-branded or private-label basis
to service providers and other businesses to assist them in diversifying their product offerings to their customer bases. In 2001,
we continued to enhance our unique strengths through our pioneering work with the Session Initiation Protocol, or SIP, an Internet
Engineering Task Force standard that has been embraced by industry leaders such as Microsoft and Cisco. These efforts culminated
in the launch of our state-of-the-art SIP infrastructure, and in doing so we became the first major VoIP service provider to deploy
an end-to-end SIP network and services. In recent years, we have continued our pioneering efforts in SIP and these efforts have
yielded significant new releases.

In
2009 we began the process of expanding the suite of our communications offerings into the global video phone services market. In
the third quarter of 2009 we entered into an agreement with ACN Pacific Pty Ltd., a wholly-owned subsidiary of ACN, Inc., or ACN,
pursuant to which we provide digital video and voice-over-IP services in Australia and New Zealand to ACN Pacific. In December
2010 we entered into an agreement with ACN Korea, a wholly-owned subsidiary of ACN, pursuant to which we provide digital video
and voice-over-IP services in Korea.

In
2010 we continued to update our network by adding a video mail feature to our video phone applications and launching our joip mobile
application in July 2010. Following the launch of the mobile application, in October 2010 we entered into a sales agency
agreement with ACN pursuant to which ACN sells a private label version of joip Mobile under the ACN Mobile World brand in the United
States and Canada. In addition, we offer the joip Mobile application on a white-label basis to other customers. Finally, we entered
into affiliate agreements with different third parties pursuant to which such third parties refer potential subscribers to our
joip Mobile application.

In
April 2011 we entered into an introducer agreement with ACN Europe B.V., a wholly-owned subsidiary of ACN, pursuant to which ACN
Europe refers potential customers in different countries in Europe to a private label version of joip Mobile sold under the ACN
Mobile World brand. In November 2011 we entered into a service agreement with Momentis U.S. Corp., or Momentis, a multi-level marketing
company, pursuant to which Momentis refers potential customers in North America to a co-branded offering of joip Mobile and other
consumer VoIP products and services.

On
April 3, 2012, we entered into an amendment to our sales agency agreement with ACN and our introducer agreement with
ACN Europe. Pursuant to the terms of the amendment, beginning April 1, 2012, we are required to pay all then-current commissions
on a timely basis as required under the agreements and a late fee in the amount of one percent per month of any past-due, unpaid
commissions (which, as of September 30, 2012, was equal to approximately $943,000). In addition, beginning July 15, 2012, we are
required to pay down any unpaid past due amounts in an amount equal to at least $15,000 per month through June 15, 2013, and at
least $25,000 per month thereafter until such time as the unpaid balance is paid in full, and are required to pay in full any unpaid,
past due amounts upon 30 days' notice. In July 2012 we began making the $15,000 monthly payment. In addition, in the event of certain
insolvency-related events defined in the agreements, all unpaid amounts will become immediately due
and payable effective immediately prior to such event.

As
a complement to the initiatives we have taken to attempt to organically expand our businesses, we have also evaluated opportunities
for growth through strategic relationships. In February 2009 we consummated a transaction with D4 Holdings pursuant to which we
sold to D4 Holdings an aggregate of 39,000,000 shares of our common stock and a warrant to purchase up to an additional 30,000,000
shares of our common stock. D4 Holdings is a private investment fund whose ownership includes owners of ACN, a direct
seller of telecommunications services. As a result of the transactions with D4 Holdings, we expect to continue to seek
opportunities to provide services to ACN and enter into other commercial transactions that give us access to ACN’s international
marketing and distribution capabilities.

From
an operational standpoint, in 2012 we continued to focus our near-term strategy and market initiatives on growing our service provider
and digital next generation communications offerings while still supporting our core VoIP reseller and direct-to-consumer business
segments.

12

Going
forward, we expect to:

•

actively market our products and services to those entities that wish to offer white-label digital next generation communications offerings;

•

pursue a targeted strategy of identifying and evaluating appropriate strategic collaborations, such as potentially engaging in commercial transactions with ACN, that we hope will continue to expand and diversify our customer base;

•

market and sell our direct-to-consumer products and services through affiliates and our affiliate program; and

•

support and maintain our current reseller base, as we expect our revenue from this key channel will continue to represent a significant percentage of our total revenue in the foreseeable future.

As
of September 30, 2012, we had negative working capital equal to approximately $5.9 million as well as negative stockholders’
equity equal to approximately $5.6 million. We believe it is probable that we will continue to experience losses and increased
negative working capital and negative stockholders’ equity in the near future and may not be able to return to positive cash
flow before we require additional cash (in addition to any further amounts we may borrow from D4 Holdings under the Fourth Loan
Agreement) in the near term. We may experience difficulties accessing the equity and debt markets and raising additional capital,
and there can be no assurance that we will be able to raise such additional capital on favorable terms or at all. If
additional funds are raised through the issuance of equity securities, our existing stockholders will experience significant further
dilution. Because of our significant losses to date and our limited tangible assets, we do not fit traditional credit lending criteria,
which could make it difficult for us to obtain loans or to access the capital markets. If we issue additional equity or convertible
debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience
significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common
stock.

Due
to the limited availability of additional loan advances under the Fourth Loan Agreement, we believe that, unless we are able to
increase revenues and generate additional cash flows, our current cash and cash equivalents will not satisfy our current projected
cash requirements beyond the foreseeable future. As a result, there is substantial doubt about our ability to continue as a going
concern.

In
addition, unless we are able to increase revenues and generate additional cash flows, based on currently projected cash flows we
believe that we may be unable to pay future scheduled interest and/or principal payments under the various loan agreements with
D4 Holdings as these obligations become due. In the event that were to occur, if D4 Holdings is not willing to waive compliance
or otherwise modify our obligations such that we are able to avoid defaulting on such obligations, D4 Holdings could accelerate
the maturity of our debts due to it. Further, because D4 Holdings has a lien on all of our assets to secure our obligations under
the loan agreements, D4 Holdings could take actions under the loan agreements and seek to take possession of or sell our assets
to satisfy our obligations thereunder. Any of these actions would likely have an immediate material adverse effect on our business,
financial condition or results of operations.

Due
to our ongoing losses and reduction in cash, we initiated restructuring activities beginning in the second quarter of 2011 in an
effort to cut operating costs significantly and better align our operations with our current business model. In accordance
with the restructuring, we instituted a reduction in force and decreased the number of full time employees from approximately 53
to 37, reduced the salaries of all remaining employees by five percent, and decreased non-material expenses as well as payments
to be made to vendors and other third parties. As of September 30, 2012, we had 23 full time employees.

In
view of our current cash resources, nondiscretionary expenses, debt and near term debt service obligations, we may begin to explore
all strategic alternatives available to it, including, but not limited to, a sale or merger of our company, a sale of our assets,
recapitalization, partnership, debt or equity financing, voluntary deregistration of its securities, financial reorganization,
liquidation and/or ceasing operations. In the event that we require but are unable to secure additional funding, we may determine
that it is in our best interests to voluntarily seek relief under Chapter 11 of the U.S. Bankruptcy Code. Seeking relief under
the U.S. Bankruptcy Code, even if we are able to emerge quickly from Chapter 11 protection, could have a material adverse effect
on the relationships between us and our existing and potential customers, employees, and others. Further, if we were unable to
implement a successful plan of reorganization, we might be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code. There
can be no assurance that exploration of strategic alternatives will result in our pursuing any particular transaction or, if we
pursue any such transaction, that it will be completed.

Trends in Our Industry and Business

A
number of factors in our industry and business have a significant effect on our results of operations and are important to an understanding
of our financial statements. These trends include:

13

Overall Economic
Factors: Our operations and earnings are affected by local, regional and global events or conditions that affect supply and
demand for telecommunications products and services. These events or conditions are generally not predictable and include, among
other things, general economic growth rates and the occurrence of economic recessions; changes in demographics, including population
growth rates; and consumer preferences. Our strategy and execution focus is predicated on an assumption that these factors will
continue to promote strong desire for the utilization of telephony products and services and that the cost and feature advantages
of VoIP alternatives will not be negatively impacted by unforeseen changes in these factors.

Industry: The
telecommunications industry is highly competitive. In recent years we have seen new sources of supply for our underlying infrastructure
that have reduced our overall costs of operation, including both advances in telecommunications technology and advances in technology
relating to telecommunications usage, and have enjoyed the benefits of competition among these suppliers for a relatively limited
amount of viable customers. A key component of our competitive position, particularly given the number and range of competing
communications products, is our ability to manage operating expenses successfully, which requires continuous management focus
on reducing unit costs and improving efficiency.

Consumer Demand: There is significant competition within the traditional
telecommunications marketplaces (landline and wireless) and also with other emerging next generation telecommunications providers,
including IP telecommunications providers, in supplying the overall telecommunications needs of businesses and individual consumers.

A key component of our competitive position, particularly
given the commodity-based nature of many of our products, is our ability to sell to a growing demand base for alternative communications
products, in both the developed and developing global marketplace. Within the developed global marketplace, our ability
to sell broadband video and voice-over-IP products and services is directly linked to the significant growth rate of broadband
adoption, and we expect this trend to continue. We benefit from this trend because our service requires a broadband Internet connection
and our potential addressable market increases as broadband adoption increases. Within the developing areas of the
world, our ability to sell alternative telephony products and services is linked to both the increasing baseline economic trends
within these countries as well as the growing desire for individuals and businesses to communicate and do business outside of
their own countries. We expect these trends to continue, and benefit from them because both the ability to afford long distance
calls and the desire to make them increase as a result.

Political
Factors: Our operations and earnings have been, and may in the future be, affected from time to time in varying degree by political
instability, social unrest (including the recent and continuing social unrest in the Middle East) and by other political developments
and laws and regulations, such as: telecommunications regulations; war, civil war, armed conflict, terrorism and other international
conflicts; restrictions on production, imports and exports; price controls; tax increases and retroactive tax claims; expropriation
of property; and cancellation of contract rights. Both the likelihood of such occurrences and their overall effect upon us vary
greatly from country to country and are not predictable. At the same time, VoIP is becoming legal in more countries as governments
seek to increase competition, and this helps us as service providers and resellers seek to meet their customers’ telecommunications
needs with newly available solutions. Both the likelihood of VoIP legalization and its overall effect upon us vary greatly from
country to country and are not predictable.

Regulatory
Factors: Our business has developed in an environment largely free from regulation. However, the United States
and other countries have begun to examine how VoIP services should be regulated and to begin instituting such regulation, and
a number of initiatives could have an impact on our business. These initiatives include the assertion of state regulatory and
taxing authorities over us, FCC rulemaking regarding emergency calling services, the imposition of law-enforcement obligations
like the Communications Assistance for Law Enforcement Act, referred to as “CALEA”, marketing restrictions and data
protection rules for Customer Proprietary Network Information, referred to as “CPNI”, access to relay services for
people with disabilities, local number portability, proposed reforms for the inter-carrier compensation system, and an ongoing
generic rulemaking considering the classification of interconnected VoIP services under federal law. Complying with regulatory
developments will impact our business by increasing our operating expenses, including legal fees, requiring us to make significant
capital expenditures or increasing the taxes and regulatory fees we pay. We may impose additional fees on our customers in response
to these increased expenses. This would have the effect of increasing our revenues per customer, but not our profitability, and
increasing the cost of our services to our customers, which would have the effect of decreasing any price advantage we may have
over traditional telecommunications companies.

Project Factors: In addition to the factors cited above, the advancement,
cost and results of particular projects depend on the outcome of: negotiations with potential partners, governments, suppliers,
customers or others; changes in operating conditions or costs; and the occurrence of unforeseen technical difficulties or enhancements.
The likelihood of these items occurring and its overall positive or negative effect upon us vary greatly from project to project
and are not predictable.

Risk Factors:
For a discussion of the impact of market risks, financial risks and other risks and uncertainties that we face, see “Item
1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC on March
28, 2012, as updated in our Quarterly Report on Form 10-Q for the quarter ended March 31,
2012, filed with the SEC on May 14, 2012, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, filed with
the SEC on August 13, 2012.

14

Revenues

Our
revenues are derived mainly from resellers, service providers, and direct consumers of our video and voice-over-IP products and
services. Revenue is recognized from these products and services as follows:

·

postpaid minutes: revenue from the sale of minutes on a postpaid basis (primarily sold to our wholesale
resellers) is recognized at the time such minutes are used;

·

prepaid minutes: prepayments for communications services and the sale of minutes are deferred and
recognized as revenue at the time communications services are provided and at the time the minutes are utilized , service charges
are levied or remaining balances expire. We conduct evaluations of outstanding prepaid balances that do not have expiration dates
or service fees associated with them to determine, based on terms and condition of agreements and historical data, whether such
balances are likely to be utilized. If we determine that balances are unlikely to be used, the deferred revenue liability is reduced
accordingly and other revenue is recognized. The outstanding prepaid balances likely to be utilized are reconciled to our deferred
revenue account and deferred revenue is increased or decreased accordingly to properly reflect our estimated liability;

·

monthly recurring charges: revenue from fees such as set monthly recurring charges based on the
level of service or calling plans that the subscriber subscribes for is recognized as the applicable service is provided; and

·

other revenues: these revenues include, but are not limited to, prepaid balances with no services
fees or expiration dates that are unlikely to be utilized.

The following sets
forth our revenues per segment for the three month and nine months ended September 30, 2012 and 2011:

Three Months Ended September 30,

Nine Months Ended September 30,

Segment

2012

2011

2012

2011

($ in thousands)

($ in thousands)

Reseller

$

2,163

$

1,278

$

5,447

$

5,383

Direct-to-consumer

989

622

3,223

1,637

Service provider

294

286

872

1,093

Other

76

29

231

92

Total Revenues

$

3,522

$

2,215

$

9,773

$

8,205

The provision
of video and voice-over-IP products and services through our reseller, direct-to-consumer and service provider channels accounted
for approximately 61.4% and 28.1%, 8.3% and 57.7%, and 28.0% and 12.9%, respectively of our total revenues for the three months
ended September 30, 2012 and 2011.

Costs and Operating Expenses

Costs and operating
expenses consist of the following: cost of revenues; research and development expenses; selling and marketing expenses; general
and administrative expenses; and depreciation and amortization.

Cost of revenues consist
primarily of network, access, termination and transmission costs paid to carriers that we incur when providing services and fixed
costs associated with leased transmission lines. The term of our contracts for leased transmission lines is generally one year
or less, and either party can terminate with prior notice.

Research and development
expenses consist primarily of costs associated with establishing our network and the initial testing of our services and compensation
expenses of software developers involved in new product development and software maintenance. Since our inception, we have expensed
all research and development costs in each of the periods in which they were incurred.

Selling and marketing
expenses consist primarily of expenses associated with our direct sales force incurred to attract potential service provider, reseller,
and customers. In addition, we expense all sales commissions paid to third parties that sell our products and services pursuant
to the terms of our agreements with such third parties.

General and administrative
expenses consist primarily of compensation and benefits for management, finance and administrative personnel, insurance premiums,
occupancy costs, legal and accounting fees and other professional fees. Additionally, we incur expenses associated with our being
a public company, including the costs of directors' and officers' insurance.

Depreciation and amortization
consists of the depreciation calculated on our fixed assets.

15

We have not recorded
any income tax benefit for net losses and credits incurred for any period from inception to September 30, 2012. The
utilization of these losses and credits depends on our ability to generate taxable income in the future. Because of the uncertainty
of our generating taxable income going forward, we have recorded a full valuation allowance with respect to these deferred assets.

Net Operating Losses

As
of September 30, 2012, we had net operating losses, or NOLs, generated in the U.S. of approximately $23.0 million and Delta Three
Israel Ltd., our wholly-owned subsidiary, had NOLs of approximately $5.0 million. Our issuance of common stock to D4 Holdings in
February 2009 constituted an “ownership change” as defined in Section 382 of the Internal Revenue Code. As a result,
under Section 382 our ability to utilize NOLs generated in the U.S. prior to February 2009 (equal to approximately $156 million)
to offset any income we may generate in the future will be limited to approximately $600,000
per year from February 2009. The NOLs began to expire in 2011 and will continue to expire at various dates until 2029 if
not utilized. Our ability to utilize our remaining NOLs could be additionally reduced if we experience any further “ownership
change,” as defined under Section 382.

Results of Operations - Three Months
Ended September 30, 2012, Compared to Three Months Ended September 30, 2011

Revenues

Revenues increased
by approximately $1.3 million, or 59%, to approximately $3.5 million for the three months ended September
30, 2012, from approximately $2.2 million for the three months ended September 30, 2011.
During this period the number of minutes carried by our network decreased by approximately 6% from
approximately 93 million minutes during the three months ended September 30, 2011, to
approximately 87 million minutes for the corresponding period in 2012. This was caused, in large part, by a decrease of
approximately 26 million minutes utilized by our second-largest reseller during the three months ended September
30, 2012, compared to the number of minutes utilized by such reseller during the corresponding period in 2011. This decrease
was partially offset by an increase in the number of minutes utilized by our largest reseller for which we terminated a large
number of calls to higher-rate destinations during this period, as this reseller resumed conducting business with us in September
2011 following a period from February 2011 in which the operations of this reseller were suspended. In addition, despite
the overall decrease in the number of minutes carrier by our network our revenue increased during this period due to an increase
in revenue in our direct-to-consumer division, as the gross margins from such division are significantly higher than the gross
margins generated by our reseller division.

Revenues
generated by our reseller division increased by approximately $885,000, or 69%, to approximately $2.2 million for the three months
ended September 30, 2012, from approximately $1.3 million for the three months ended September
30, 2011. This increase was caused in large part by our largest reseller resuming conducting
business with us in September 2011 following a period from February 2011 in which the operations
of this reseller were suspended. Our two largest resellers accounted for approximately
$1.9 million, or approximately 87%, of the revenue generated from our reseller division for the three months ended September
30, 2012, which represented approximately 53% of our total revenue for such period. By
comparison, for the three months ended September 30, 2011, our two largest resellers
accounted for approximately 70% of the revenue generated from our reseller division, or approximately 41% of our total revenue
during such period.

Revenues generated
by our service provider division increased by approximately $8,000, or 3%, from approximately $286,000 for the three months ended
September 30, 2011, to approximately $294,000 for the three months ended September
30, 2012. This increase was due to a one-time set-up fee we received from a service provider during the three months ended
September 30, 2012.

Sales
to direct consumers increased by approximately $367,000, or 59%, to approximately $989,000 for the three months ended September
30, 2012, from approximately $622,000 for the three months ended September 30, 2011. Revenues
generated through our iConnectHere offering declined by approximately $77,000 from approximately $215,000 for the three months
ended September 30, 2011, to approximately $138,000 for the three months ended September
30, 2012. This was offset by the revenues generated by our joip Mobile offering, which increased from $389,000 for the three
months ended September 30, 2011, to approximately $843,000 for the three months ended September
30, 2012, primarily as a result of the sales agency agreement we entered
into with ACN, the introducer agreement we entered into with ACN Europe and the sales agreement we entered into with Momentis.

Costs and Operating
Expenses

Cost
of revenues. Cost of revenues increased by approximately $835,000, or 55%, from approximately $1.5 million
for the three months ended September 30, 2011, to approximately
$2.4 million for the three months ended September 30, 2012. Our
network rent cost decreased slightly by approximately $33,000 from approximately $298,000 for the three months ended September
30, 2011, to approximately $265,000 for the three months ended September 30, 2012.
Our termination cost increased by approximately $883,000, or 81%, from approximately $1.1 million for the three months ended
September 30, 2011, to approximately $2.0 million for the three
months ended September 30, 2012. The main reason for the increase
in termination cost was the resumption of operations of our largest reseller during September 2011, which generated approximately
$1.4 million of total termination costs for the three months ended September 30, 2012,
partially offset by a decline in the total termination costs of our second-largest reseller of approximately $340,000 during this
period. In addition, during this period our largest reseller utilized minutes through our network that
were more expensive for us to purchase than the minutes that were utilized by our second-largest reseller during this period.

16

Research
and development expenses. Research and development expenses decreased by approximately $92,000, or 25%, from approximately
$366,000 for the three months ended September 30, 2011, to
approximately $274,000 for the three months ended September 30, 2012.
The main reason for the decrease was the reduction in the number of employees in our research and development department. As a
percentage of revenues, research and development expenses for the three months ended September 30, 2012, was approximately 8%
compared to approximately 17% for the three months ended September 30, 2011.

Selling
and marketing expenses. Selling and marketing expenses increased by approximately $43,000, or 10%, to approximately
$467,000 for the three months ended September 30, 2012, from
approximately $424,000 for the three months ended September 30, 2011.
The main reason for the increase was an increase in commissions recorded for ACN, ACN Europe and Momentis, offset by a reduction
in the number of employees in our sales and marketing department. As a percentage of revenues, selling and marketing expenses decreased
to approximately 13% for the three months ended September 30, 2012, from approximately 19% for
the three months ended September 30, 2011.

General
and administrative expenses. General and administrative expenses decreased by approximately $41,000, or 10%, to
approximately $366,000 for the three months ended September 30, 2012, from approximately $407,000 for the three months ended September
30, 2011. During the three months ended September 30, 2011, we recorded a credit of $50,000 as a reverse for losses on accounts
receivable in connection with outstanding amounts owed to us by our then-largest reseller. Excluding this one-time item, our general
and administrative expenses would have decreased in the three months ended September 30, 2012, by approximately $91,000 from the
three months ended September 30, 2011, primarily due to a reduction in salaries as a result of our restructuring as well as a reduction
in payments to be made to our vendors and other third parties.

Depreciation
and amortization. Depreciation and amortization increased by approximately $3,000, or 8%, from approximately
$36,000 for the three months ended September 30, 2011, to approximately
$39,000 for the three months ended September 30, 2012. This was caused by
an acquisition of fixed assets during this period.

Income (Loss) from Operations

For the three months
ended September 30, 2012, we recorded income from operations of approximately $17,000 compared to a loss from operations of approximately
$542,000 for the three months ended September 30, 2011, due to the factors set forth above.

Interest Expense, Net

We
recorded interest expense of approximately $416,000 for the three months ended September 30,
2012, compared to approximately $329,000 for the three months ended September
30, 2011. This increase was due primarily to interest paid and recorded under our loan agreements with D4 Holdings of approximately
$140,000, and $261,000 we recorded for the warrant we issued to D4 Holdings in connection with the Second Loan Agreement and the
warrant and Convertible Note we issued to D4 Holdings in connection with the Third Loan Agreement.

Income Taxes, Net

We recorded net income
tax expenses of $2,000 for the three months ended September 30, 2012, compared to $1,000 for the three months ended September 30,
2011.

Net Loss

For the three months
ended September 30, 2012, we recorded a net loss of approximately $401,000 compared to a net loss of approximately $872,000 for
the three months ended September 30, 2011, due to the factors set forth above.

Revenues
increased by approximately $1.6 million, or 20%, to approximately $9.8 million for the nine months ended September
30, 2012, from approximately $8.2 million for the nine months ended September 30, 2011.
During this period the number of minutes carried by our network decreased by approximately 10% from
approximately 279 million minutes during the nine months ended September 30, 2011, to
approximately 255 million minutes for the corresponding period in 2012. This was caused, in large part, by a decrease of
approximately 52 million minutes utilized by our second-largest reseller during the nine months ended September
30, 2012, compared to the number of minutes utilized by such reseller during the corresponding period in 2011. This decrease
was partially offset by an increase in the number of minutes from our largest reseller for which we terminated a large number
of calls to higher-rate destinations during this period, as this reseller resumed conducting business with us in September
2011 following a period from February 2011 in which the operations of this reseller were suspended. In addition, despite
the overall decrease in the number of minutes carrier by our network our revenue increased during this period due to an increase
in revenue in our direct-to-consumer division, as the gross margins from such division are significantly higher than the gross
margins generated by our reseller division.

Revenues
generated by our reseller division were approximately $5.4 million for both of the nine months ended September
30, 2012 and 2011, although the revenues generated by division for the nine months ended September 30, 2012, reflected an increase
in each subsequent quarter.Our two largest resellers accounted for
approximately $4.4 million, or approximately 81%, of the revenue generated from our reseller division for the nine months ended
September 30, 2012, which represented approximately 45% of our total revenue for such
period. By comparison, for the nine months ended September
30, 2011, our two largest resellers accounted for approximately $3.9 million, or approximately
72%, of the revenue generated from our reseller division, or approximately 47% of our total revenue during such period.

Revenues generated
by our service provider division decreased by approximately $221,000, or 21%, from approximately $1.1 million for the nine months
ended September 30, 2011, to approximately $872,000 for the nine months ended September
30, 2012. This decrease was due to one-time set-up fees we received from three different service providers during the nine
months ended September 30, 2011.

Sales
to direct consumers increased by approximately $1.6 million, or 100%, to approximately $3.2 million for the nine months
ended September 30, 2012, from approximately $1.6 million for the nine months ended September
30, 2011. Revenues generated through our iConnectHere offering declined by approximately $234,000 from approximately $700,000
for the nine months ended September 30, 2011, to approximately $466,000 for the nine months ended
September 30, 2012. This was offset by the revenues generated by our joip Mobile offering, which
increased from $874,000 for the nine months ended September 30, 2011, to approximately $2.7 million
for the nine months ended September 30, 2012, primarily as a result of the sales
agency agreement we entered into with ACN, the introducer agreement we entered into with ACN Europe and the sales agreement we
entered into with Momentis.

Costs and Operating
Expenses

Cost of revenues.Cost of revenues decreased by approximately $300,000, or 5%, from approximately
$5.9 million for the nine months ended September 30, 2011, to approximately $6.2 million
for the nine months ended September 30, 2012. Our network rent cost decreased by approximately
$109,000, or 13%, from approximately $891,000 for the nine months ended September 30,
2011, to approximately $782,000 for the nine months ended September 30, 2012, and
our termination cost increased by approximately $518,000, or 11%, from approximately $4.5 million for the nine months ended September
30, 2011 to approximately $5.0 million for the nine months ended September 30,
2012. The main reason for the increase in termination costs was the resumption of operations of our largest reseller
during September 2011, which utilized minutes through our network that were most expensive for us to purchase than the minutes
that were utilized by our second-largest reseller during the nine months ended September 30, 2012.

Research
and development expenses. Research and development expenses decreased by approximately $384,000, or 31%, from approximately
$1.3 million for the nine months ended September 30, 2011,
to approximately $874,000 for the nine months ended September 30, 2012.
The main reason for the decrease was the reduction in the number of employees in our research and development department. As a
percentage of revenues, research and development expenses for the nine months ended September 30, 2012, was approximately 9%
compared to approximately 15% for the nine months ended September 30, 2011.

Selling
and marketing expenses. Selling and marketing expenses remained constant at approximately $1.5 million for the
nine months ended September 30, 2012 and 2011. During the nine
months ended September 30, 2012 there was a reduction in the number
of employees in our sales and marketing department and a corresponding reduction in expenses, offset by an increase in commissions
paid to ACN, ACN Europe and Momentis. As a percentage of revenues, selling and marketing expenses decreased to approximately 16%
for the nine months ended September 30, 2012, from approximately 19% for the nine months ended
September 30, 2011.

General
and administrative expenses. General and administrative expenses increased by approximately $267,000, or 34% to
approximately $1.0 million for the nine months ended September 30, 2012, from approximately $775,000 for the nine months ended
September 30, 2011. During the nine months ended September 30, 2011, we recorded a one-time reversal of an accrual of $706,000
for expenses expected to arise from our litigation with Centre One and a one-time reversal of an accrual for tax liability of $158,000
that was recorded. This was partially offset by $146,000 we recorded in 2011 as a provision for losses on accounts receivable in
connection with outstanding amounts owed to us by our largest reseller. Excluding these one-time items, our general and administrative
expenses would have decreased in the nine months ended September 30, 2012, by approximately $451,000 from the nine months ended
September 30, 2011, primarily due to a reduction in salaries arising from our restructuring as well as a reduction in payments
to be made to our vendors and other third parties.

18

Accrual
for commercial rent tax. As
discussed below under – "Liquidity and Capital Resources", on July 5, 2011, we
received a notice from the New York City Department of Finance, which claimed that we had not paid commercial rent tax required
under the New York City Administrative Code from June 1998 through May 2008 for the two offices that we had leased during that
time. The notice stated that we are obligated to pay the outstanding tax amounts, as well as significant interest and penalties
that were assessed on the unpaid amounts as well as for the failure to file the applicable tax returns. For the nine months ended
September 30, 2011, we recorded $300,000 as a provision for tax liability.

Depreciation
and amortization. Depreciation and amortization decreased by approximately $32,000, or 23%, from approximately $141,000
for the nine months ended September 30, 2011, to approximately
$109,000 for the nine months ended September 30, 2012. This was caused by
a decline in the value of our fixed assets during this period.

Income (Loss) from Operations

For
the nine months ended September 30, 2012, we recorded income from operations of approximately $42,000 compared to a loss from operations
of approximately $1.7 million for the nine months ended September 30, 2011, due to the factors set forth above.

Interest Expense, Net

We
recorded interest expense of approximately $1.3 million for the nine months ended September 30,
2012, compared to approximately $761,000 for the nine months ended September
30, 2011. This increase was due primarily to interest recorded under our loan agreements with D4 Holdings of approximately $408,000,
and the expense equal to $782,000 we recorded for the warrant we issued to D4 Holdings in connection with the Second Loan Agreement
and the warrant and Convertible Note we issued to D4 Holdings in connection with the Third Loan Agreement.

Income Taxes, Net

We recorded net income
tax expenses of $6,000 for the nine months ended September 30, 2012, compared to $9,000 for the nine months ended September 30,
2011.

Net Loss

For the nine months
ended September 30, 2012, we recorded a net loss of approximately $1.3 million compared to a net loss of approximately $2.5 million
for the nine months ended September 30, 2011, due to the factors set forth above.

Liquidity and Capital Resources

Since
our inception in June 1996, we have incurred significant operating and net losses due in large part to the start-up and development
of our operations and our losses from operations. For the nine months ended September 30, 2012, we recorded net income from
operations of approximately $42,000 compared to a net loss from operations of approximately $1.7 million for the nine months ended
September 30, 2011. To date, we have an accumulated deficit of approximately $182.6 million.

As
of September 30, 2012, we had cash and cash equivalents of approximately $288,000 and restricted cash and
short-term investments of approximately $272,000, or a total of cash, cash equivalents and restricted cash of $560,000, a
decrease of approximately $6,000 from December 31, 2011. The increase in cash and cash equivalents (excluding the restricted
cash and short-term investments) was primarily caused by net cash provided by operating activities of approximately $50,000
during the nine months ended September 30, 2012, and by net cash used in investing activity of purchasing new equipment of
approximately $56,000 during the nine months ended September 30, 2012.

Cash
used in or provided by operating activities is net loss adjusted for certain non-cash items and changes in assets and liabilities.
We had positive cash flow from operating activities of approximately $50,000 and negative cash flow from operating activities
of approximately $2.0 million during the nine months ended September 30, 2012 and 2011, respectively. The increase in our
cash generated from operating activities was primarily due to a decrease in our net loss of $1.2 million, accumulated interest
on short-term loans of $269,000, amortization of $782,000 related to convertible notes and an increase in deferred revenues of
$154,000, offset by an increase in accounts receivables of $205,000.

19

Net cash used in or
provided by investing activities is generally driven by our capital expenditures and changes in our short and long-term investments. For
the nine months ended September 30, 2012, we expensed $56,000 for purchases of new equipment, compared to $99,000 for the nine
months ended September 30, 2011. In addition, during the nine months ended September 30, 2012, restricted cash equal to
$131,000 that was underlying the letter of credit previously provided by us to the landlord of our subsidiary's office in Jerusalem
was released, since such letter of credit is no longer required under the extension of the lease that we executed during this
period. During the nine months ended September 30, 2012, a reserve of $242,000 was temporarily held back by our previous payment
processor pending the final calculation and clearance of all payments processed by such third party.

Net cash used in or provided
by financing activities is generally driven by drawing down amounts available under lines of credit available to us, issuing shares
of our capital stock and receiving cash that we had previously pledged or otherwise deposited as security for our lenders and
creditors. For the nine months ended September 30, 2012, we did not draw down any amounts under our loan agreements with D4 Holdings.

Financing
cash flows have historically consisted primarily of payments of capital leases and proceeds from the exercise of options we have
granted to our employees and directors. In February 2009 we consummated a transaction with D4 Holdings pursuant to which we sold
to D4 Holdings an aggregate of 39,000,000 shares of our common stock and a warrant to purchase up to an additional 30,000,000 shares
of our common stock for an aggregate purchase price of $1,200,000. In addition, on March 1, 2010, we and our subsidiaries
entered into the First Loan Agreement with D4 Holdings pursuant to which D4 Holdings agreed to provide us and our subsidiaries
a line of credit in a principal amount of $1,200,000. On August 10, 2010, we and our subsidiaries entered into the Second
Loan Agreement with D4 Holdings, pursuant to which D4 Holdings agreed to provide us and our subsidiaries an additional line of
credit in a principal amount of $1,000,000. In connection with the Second Loan Agreement, we issued D4 Holdings a warrant to purchase
up to 4,000,000 shares of our common stock at an exercise price of $0.1312 per share. We have drawn down all amounts available
to be borrowed under the first two lines of credit. On March 2, 2011, we and our subsidiaries entered into the Third Loan Agreement
with D4 Holdings pursuant to which D4 Holdings agreed to provide us and our subsidiaries an additional line of credit in a principal
amount of $1,600,000. Pursuant to the terms of the Convertible Note we issued to D4 Holdings in connection with the Third Loan
Agreement, D4 Holdings may elect to convert all or any portion of the outstanding principal amount under the Convertible
Note into that number of shares of our common stock determined by dividing such principal amount by $0.08 (as may be adjusted under
the terms of the Convertible Note). Simultaneous with our entering into the
Third Loan Agreement, D4 Holdings and we entered into an amendment of the First Loan Agreement pursuant to which (among other things)
the maturity date for repayment of principal under the First Loan Agreement was extended from March 1, 2011, to March 1, 2012.
The maturity date was subsequently extended by oral agreement of the parties to July 1, 2012, and then subsequently orally
extended again to January 2, 2014, pending the parties finalizing and entering into a formal amendment.
In connection with the Third Loan Agreement, we issued D4 Holdings a warrant to purchase up to 1,000,000 shares of our common stock
at an exercise price of $0.096 per share. We have drawn down the aggregate principal
amount available under the Third Loan Agreement, the principal amount of which can be converted by D4 Holdings into an aggregate
of 20,000,000 shares of our common stock. On September 12, 2011, we and our subsidiaries entered into the Fourth Loan Agreement
with D4 Holdings, pursuant to which D4 Holdings agreed to provide us and our subsidiaries an additional line of credit in a principal
amount of $300,000. As of September 30, 2012, we have drawn down the aggregate amount of $200,000 from D4 Holdings pursuant to
notices of borrowing under the Fourth Loan Agreement.

On November 13, 2012,
each of us, our subsidiary and DME Solutions, Inc. entered into the Third Amendment to Loan and Security Agreements, or the "Third
Amendment", and the Amendment to Warrant Agreements, or the "Warrants Amendment", with D4 Holdings. Pursuant to
the Third Amendment and the Warrants Amendment,

·

the maturity date for repayment of principal and interest under the First Loan Agreement was extended to January 2, 2014;

·

the maturity date for repayment of principal and interest under the Second Loan Agreement was extended to January 2, 2015;

·

the maturity date for repayment of principal and interest under each of the Third and Fourth Loan Agreements was extended to
January 2, 2016;

·

all interest outstanding under each of the loan agreements was added to the principal amount outstanding
under the respective loan agreement and the promissory note issued pursuant to each respective
loan agreement was increased by such amount; and

·

the exercise price under each of the Warrant Agreements entered into by the Company and D4 Holdings as of February 12, 2009,
August 10, 2010, and March 2, 2011 was amended to $0.02 per share.

In connection with the extension of the
maturity dates under the Third Amendment, we issued to D4 Holdings a Warrant, or together with the Third Amendment and the Warrants
Amendment, the "Transaction Documents", exercisable for ten years, to purchase up to 10,000,000 shares of our common
stock at an exercise price of $0.02 per share.

There
were no options exercised by our employees or directors during the nine months ended September 30, 2012. For the nine months ended
September 30, 2011, we paid $7,000 for capital leases. We did not record any expenses for capital leases during the nine
months ended September 30, 2012.

On
July 5, 2011, we received a notice from the New York City Department of Finance that claimed that we had not paid commercial
rent tax required under the New York City Administrative Code from June 1998 through May 2008 for the two offices that we had
leased during that time. The notice stated that we are obligated to pay the outstanding tax amounts, as well as significant
interest and penalties that were assessed on the unpaid amounts as well as for the failure to file the applicable tax
returns. On August 15, 2011, we filed a response contesting the assessment and/or attempting to negotiate a reduction in the
amounts to be paid. Our appeal was rejected in July 2012 by an examiner in the Department of Finance, and we have
subsequently engaged and begun discussions with a manager in the Department of Finance and submitted additional supporting
materials. The final outcome of this assessment and our negotiations with the New York City Department of Finance cannot be
determined at this time. In the event that we are required to pay all or most of the amounts claimed by the New York City
Department of Finance this would have a material adverse effect on our financial condition and liquidity. During 2011 we
recorded $300,000 as a provision for commercial rent tax.

We
experience fluctuations in our cash cycle, as we generally make payments to our termination suppliers more frequently (often on
a weekly basis) than we receive payments from our customers (often on a monthly basis). In the event one of our customers
did not pay us, we would experience a direct loss of the amounts we had already paid to our termination suppliers. We
maintain our free cash in accounts with major banks located in the United States, and generally do not invest such cash in short
or long-term investments. As a way to try to offset our declining cash position we generally seek to extend payment
terms to our suppliers other than our termination providers.

20

We
have historically obtained our funding from our utilization of the remaining proceeds from our initial public offering, offset
by positive or negative cash flow from our operations, and most recently from the sale of shares of our common stock to D4 Holdings
in February 2009 and borrowings under our loan agreements with D4 Holdings. These proceeds are maintained as cash, restricted cash,
and short and long term investments. We have sustained significant operating losses in recent periods, which have led to a significant
reduction in our cash reserves.

On
April 3, 2012, we entered into an amendment to our sales agency agreement with ACN and our introducer agreement with
ACN Europe. Pursuant to the terms of the amendment, beginning April 1, 2012, we are required to pay all then-current commissions
on a timely basis as required under the agreements and a late fee in the amount of one percent per month of any past-due, unpaid
commissions (which, as of September 30, 2012, was equal to approximately $943,000). In addition, beginning July 15, 2012, we are
required to pay down any unpaid past due amounts in an amount equal to at least $15,000 per month through June 15, 2013, and at
least $25,000 per month thereafter until such time as the unpaid balance is paid in full, and are required to pay in full any unpaid,
past due amounts upon 30 days' notice. In July 2012 we began making the $15,000 monthly payment. In addition, in the event of certain
insolvency-related events defined in the agreements, all unpaid amounts will become immediately due
and payable effective immediately prior to such event.

As
of September 30, 2012, we had negative working capital equal to approximately $5.9 million as well as negative stockholders’
equity equal to approximately $5.6 million. We believe it is probable that we will continue to experience losses and increased
negative working capital and negative stockholders’ equity in the near future and may not be able to return to positive cash
flow before we require additional cash (in addition to any further amounts we may borrow from D4 Holdings under the Fourth Loan
Agreement) in the near term.We may experience difficulties accessing the equity and debt markets and raising additional
capital, and there can be no assurance that we will be able to raise such additional capital on favorable terms or at all. If
additional funds are raised through the issuance of equity securities, our existing stockholders will experience significant further
dilution. Because of our significant losses to date and our limited tangible assets, we do not fit traditional credit lending criteria,
which could make it difficult for us to obtain loans or to access the capital markets. If we issue additional equity or convertible
debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience
significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common
stock.

Due
to the limited availability of additional loan advances under the Fourth Loan Agreement, we believe that, unless we are able to
increase revenues and generate additional cash, our current cash and cash equivalents will not satisfy our current projected cash
requirements beyond the foreseeable future. As a result, there is substantial doubt about our ability to continue as a going concern.

In
addition, unless we are able to increase revenues and generate additional cash, based on currently projected cash flows we believe
that we may be unable to pay future scheduled interest and/or principal payments under the various loan agreements with D4 Holdings
as these obligations become due. In the event that were to occur, if D4 Holdings is not willing to waive compliance or otherwise
modify our obligations such that we are able to avoid defaulting on such obligations, D4 Holdings could accelerate the maturity
of our debts due to it. Further, because D4 Holdings has a lien on all of our assets to secure our obligations under the loan agreements,
D4 Holdings could take actions under the loan agreements and seek to take possession of or sell our assets to satisfy our obligations
thereunder. Any of these actions would likely have an immediate material adverse effect on our business, financial condition or
results of operations.

Due
to our ongoing losses and reduction in cash, we initiated restructuring activities beginning in the second quarter of 2011 in an
effort to cut our operating costs significantly and better align our operations with our current business model. In
accordance with the restructuring, we instituted a reduction in force and decreased the number of full time employees from approximately
53 to 37, reduced the salaries of all remaining employees by five percent, and decreased our non-material expenses as well as payments
to be made to vendors and other third parties. As of September 30, 2012, we had 23 full time employees.

In view of our current
cash resources, nondiscretionary expenses, debt and near term debt service obligations, we may begin to explore all strategic alternatives
available to us, including, but not limited to, a sale or merger of our company, a sale of our assets, recapitalization, partnership,
debt or equity financing, voluntary deregistration of its securities, financial reorganization, liquidation and/or ceasing operations.
In the event that we are unable to secure additional funding, we may determine that it is in our best interests to voluntarily
seek relief under Chapter 11 of the U.S. Bankruptcy Code. Seeking relief under the U.S. Bankruptcy Code, even if we are able to
emerge quickly from Chapter 11 protection, could have a material adverse effect on the relationships between us and our existing
and potential customers, employees, and others. Further, if we were unable to implement a successful plan of reorganization, we
might be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code. There can be no assurance that exploration of strategic
alternatives will result in our company pursuing any particular transaction or, if we pursue any such transaction, that it will
be completed.

21

Off-Balance Sheet Arrangements

None.

Contingencies

For a discussion of
contingencies, see Note 3 of the Notes to the Condensed Consolidated Financial Statements of this report, which is incorporated
herein by reference.

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and
Procedures.

Each of our principal
executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form
10-Q, has concluded that, based on such evaluation, our disclosure controls and procedures as of September 30, 2012, were adequate
and effective to ensure that material information required to be disclosed by us in the reports that we file and submit under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Changes in Internal Controls.

There were no changes
in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal
Proceedings.

There have been no
material changes to our Legal Proceedings as described in Item 3 of our Annual Report on Form 10-K for the year ended December
31, 2011, as filed with the SEC on March 28, 2012.

We are not a party
to any other material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which we
are a party or of which any of our property is the subject.

Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds.

The information
in Part II, Item 5 of this Quarterly Report on Form 10-Q is incorporated by reference into this Item 2. The Warrant was
issued pursuant to an exemption from registration under the Securities Act of 1933, as amended.

Item 5. Other Information

The following disclosure would otherwise be filed on Form 8-K under the Items 1.01, 2.03 and 3.02 of Form
8-K.

On November 13, 2012, each of us, our subsidiary
and DME Solutions, Inc. entered into the Third Amendment and the Warrants Amendment with D4 Holdings. Pursuant to the Third
Amendment and the Warrants Amendment,

·

the maturity date for repayment of principal and interest under the First Loan Agreement was extended to January 2, 2014;

·

the maturity date for repayment of principal and interest under the Second Loan Agreement was extended to January 2, 2015;

·

the maturity date for repayment of principal and interest under each of the Third and Fourth Loan Agreements was extended to
January 2, 2016;

·

all interest outstanding under each of the loan agreements was added to the principal amount outstanding
under the respective loan agreement and the promissory note issued pursuant to each respective
loan agreement was increased by such amount; and

·

the exercise price under each of the Warrant Agreements entered into by the Company and D4 Holdings as of February 12, 2009,
August 10, 2010, and March 2, 2011 was amended to $0.02 per share.

In connection with the extension of the
maturity dates under the Third Amendment, we issued to D4 Holdings the Warrant, exercisable for ten years, to purchase up to 10,000,000
shares of our common stock at an exercise price of $0.02 per share.

Our company is majority-owned by D4 Holdings.
The ultimate ownership of D4 Holdings includes owners of ACN, Inc. Each of Robert Stevanovski, Anthony Cassara and David Stevanovski,
members of our Board of Directors, is a principal of D4 Holdings. As a result, each of these individuals may be deemed to have
a direct or indirect interest in the transactions contemplated by the Transaction Documents. In accordance with the Company’s
Audit Committee Charter, the Transaction Documents and the transactions contemplated thereby were approved by the Audit Committee,
which includes those directors who are not affiliated with D4 Holdings.

Item 6. Exhibits.

See Exhibit Index on
page 24 for a description of the documents that are filed as Exhibits to this Quarterly Report on Form 10-Q or incorporated
by reference herein.

22

SIGNATURES

Pursuant to the requirements
of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.

Certification of the Principal Executive
Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of the Principal Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

Certification of the Principal Executive
Officer, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of the Principal Financial Officer, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

XBRL Instance Document.*

101.SCH

XBRL Taxonomy Extension Schema Document.*

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document.*

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document.*

101.LAB

XBRL Taxonomy Extension Label Linkbase Document.*

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document.*

*

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates such information by reference.